The advertisements for debt settlement are nearly irresistible to the overextended. They make the process sound almost painless; some even promise that government programs will stomp down debts.
Sounds great, except in reality debt settlement can be fraught with difficulties and sour consequences, and there's no magical government program to make it easier, say experts in the field. In fact, debt-settlement companies have been charged in more than 250 federal and state false-advertising cases in the last several years. The companies have also been the source of thousands of consumer complaints.
"This is an industry that's built on false promises," said Linda Sherry, director of national priorities for advocacy group Consumer Action. "They're just funneling money away from families who need it."
There is a real government program coming, although it won't be welcomed by shady companies.
Next month, new Federal Trade Commission rules for debt-settlement companies will begin going into effect.
There are three major components to the rules:
• Fees: The biggest change is that debt-settlement companies will be barred from collecting upfront fees. In the past, some companies have collected thousands in fees without renegotiating a single debt agreement. Under the new rules, these firms will be able to charge a fee only after the company has successfully renegotiated, settled or reduced at least one of the consumer's debts.
Fees must be spelled out in formal written agreements between the consumers and creditors. And the fees must be proportionate to the amount of debt that's been settled.
• Dedicated accounts: If the consumer pays into a dedicated account as part of the settlement agreement, that account must be established at a financial institution that offers federal deposit insurance. In addition, the account must be in the consumer's name and control, rather than in the control of the debt-settlement company.
• Better disclosure: Settlement companies will be required to spell out the negative potential consequences of a settlement. Debt settlement can harm your credit as dramatically as a bankruptcy, said David Jones, president of the Assn. of Independent Consumer Credit Counseling Agencies. The disclosure rules go into effect Sept. 27. The rules banning upfront fees go into effect Oct. 27.
Until they go into effect, it's buyer beware. More than likely, consumers will continue to be charged upfront fees. In fact, some settlement companies may ramp up their advertising with pitches akin to "Act now, before this program expires!"
If debt settlement isn't a good option, what can you do if you can't pay your debts?
Your best bet is to go to a nonprofit credit counseling firm to get advice about ways to pay back your debts without a settlement or bankruptcy. You can find a nonprofit credit counselor by clicking the "find a counselor" buttons on the websites of the two major counseling trade groups, the National Foundation for Consumer Credit (www.nfcc.org) or the Assn. of Independent Consumer Credit Counseling Agencies (www.aiccca.org).
A counselor affiliated with either of these groups will evaluate your financial situation free. If a pay plan overseen by the counselor is set up, that might involve modest fees.
If it's determined that you have no way to pay off your debts in full, the counselor can walk you through your next steps. In some cases, the counselor may advise you to work directly with your creditors to reduce the amount you owe. You can negotiate directly with your creditors as effectively as the debt-settlement firms, experts maintain. But note that creditors might not negotiate with you if they're convinced that you have options other than bankruptcy.
In some cases, the best option is, indeed, bankruptcy, Sherry said. That's because it wipes out debts permanently.
And because consumers can't file for bankruptcy within eight years of their last filing, creditors have some solace that you won't repeat your mistakes. Consequently, they might be more likely to issue new credit to a recently bankrupt consumer than they would be to one who merely settled his or her debts for less than 100 cents on the dollar, she said.
"I think a lot of people are afraid of bankruptcy," Sherry said. "But for some people, it's the best option."